The Roth IRA made easy

Starting a Roth IRA is one of the easiest — and best — steps you can take to save for retirement. But you should understand the Roth IRA rules before investing in them.

I know I've written a lot about the Roth IRA in the past, but I still get questions all the time. People find them intimidating. For example, Lynn wrote last week:

I'm a 36-year-old single mother of two. I want to start investing for my future, but I am so overwhelmed by all the information. I was wondering if you could give me some advice on my best options for a Roth IRA. I am a school teacher and earn $41,000 per year.

I am going to do more research, but I would appreciate some advice from someone who already has expertise in this area. I am not sure what I need to start a Roth IRA, or who I should go with. I don't know much about mutual funds or anything of that sort, so any help and advice would be appreciated.

Let's clear things up: A Roth IRA does not need to be confusing. In fact, a Roth IRA is actually fairly easy to understand.

Note: This post is going to keep things basic. For more detailed info, see the resources at the end of this article, or consult a financial planner.

Roth IRA Basics

The Roth IRA is an individual retirement arrangement: It lets you save and invest for your future. An IRA is simply a holding account. It's a label. When you own a Roth IRA, it contains nothing. It's like a bucket, a place for you to put things. (Most people think of an IRA as an individual retirement account, which is fine, but it's actually an “arrangement.”)

The things you put in your bucket are investments. You might, for example, buy a stock to put in your retirement account. Or maybe government bonds. Or certificates of deposit. The important thing to understand is that a Roth IRA is not an investment — it's a place to put investments.

With many retirement accounts — such as 401(k)s and traditional IRAs — you contribute pre-tax money and are taxed when you take the money out during retirement. Because they work with after-tax money, earnings from a Roth IRA can be withdrawn tax-free at retirement.

Roth IRA Rules and Requirements

Because Roth IRAs are meant to encourage ordinary people to save for retirement, not everyone qualifies for them. If you do qualify, you can contribute up to $5,000 to your Roth IRA every year. If you're 50 or over, you can contribute $6,000.

Who qualifies? Nearly everyone. However:

If your tax filing status is single and you earn more than $105,000 per year, your contributions are restricted.

If you're married filing jointly, your contributions are limited if your household earns more than $160,000 per year.

You can use a Roth IRA even if you have a 401(k) or other retirement plan, but you must make your contributions by the tax deadline each year.

The rules are a little more complex than that, but those are the basics. If you need more info, take a look at the resources listed at the end of this article.

Where to Open a Roth IRA

Deciding where to start your Roth IRA is the most difficult part of the process. Many financial institutions offer IRAs. Each has its own strengths and weaknesses. Don't fret about finding the perfect match — find a good match and then get started.

To make things simple, here are four big companies that provide Roth IRAs (though these are by no means your only options):

Fidelity Investments offers a no-fee IRA. There's a $2,500 minimum initial investment, but this is waived if you commit to $200/month automatic contributions. They offer 4,600 mutual funds, about a quarter of which have no transaction fee. In short, you can open a no-cost IRA at Fidelity with a $200 starting investment if you invest in mutual funds and you agree to contribute $200/month. Apply for a Roth IRA with Fidelity.

It's also possible to open a no-cost Roth IRA at The Vanguard Groupif you elect to receive electronic statements. Otherwise, a $20 annual fee is charged until your Roth IRA balance is over $10,000. Your minimum to get started is $3,000 — except that you can start with just $1,000 in the company's STAR fund. (The STAR fund is an mutual fund of mutual funds, a safe choice for beginners.) Additional contributions require a minimum of $100 unless you use their Automatic Investment Plan, in which case the minimum is $50. There are no fees to purchase the STAR fund. Start a Roth IRA at Vanguard.

T. Rowe Price charges $10/year for Roth IRA accounts until you have a balance above $5,000, after which there is no fee. You need $1,000 to open your IRA, but this minimum goes away if you sign up to contribute at least $50/month with the Automatic Asset Builder. There are no sales fees or commissions to invest this money in T. Rowe Price mutual funds. Open an IRA at T. Rowe Price.

Scottrade resists charging its customers set-up, annual or maintenance fees for its online trading services and also offers them the opportunity to get a refund of up to $100 in transfer fees from other brokers for bringing their Roth IRA to Scottrade. Scottrade's pricing on trades is fairly simple: $7 for stocks $1 and above for online market and limit equity orders. You might also consider a Scottrade checking, savings or money market account. These can be joined with a trading account to help easily fund transactions.

Opening a Roth IRA is easy. You'll need some minimal bank account info and about 30-60 minutes of free time. If you've ever filled out a job application or applied for a credit card, you can certainly open a Roth IRA. Once you've completed your application, you can transfer money to the account. It might have to sit in a money market fund until you have enough saved to buy your first mutual fund, but that's okay. You're developing the saving habit!

Note: I'm a big fan of automatic investment plans. Most of these companies offer some sort of program that will pull money from your bank account every month to invest in stocks or mutual funds that you designate. By setting aside $50 or $100 or $500 in this way, saving becomes a habit.

Which Investments to Choose

Here's where I cop out. I'm not a financial adviser. I don't know your goals or risk tolerance. I can't tell you were to invest.

And to be honest, where you invest doesn't matter nearly as much as the fact that you do invest. To get some ideas, browse through the investing archives here at Get Rich Slowly. (Maybe start with these “lazy portfolios.”)

If you're really stressed, pick a target-date fund that most closely matches the year you'll retire. This probably isn't the best option, but it's fine. Just use it while you get in the habit of making contributions. You can always switch the money to something more appropriate later.

I've revised these articles and compiled them into a free e-book called The Get Rich Slowly Guide to Roth IRAs (518kb PDF). (Note that this e-book was produced in April 2008, so some of the info is a little out of date, especially about Zecco.) And if you want the official word on the subject, check out IRS publication 590, which is all about IRAs.

Now's the part where you can tell Lynn how easy it is to set up a Roth IRA. (And share what sort of things you've invested in.) My own Roth IRA started with stupid stock picks (Countrywide, The Sharper Image) and has moved toward index funds. I'm all about making things easy right now!

In 2006, J.D. founded Get Rich Slowly to document his quest to get out of debt. Over time, he learned how to save and how to invest. Today, he's managed to reach early retirement! He wants to help you master your money — and your life. No scams. No gimmicks. Just smart money advice to help you reach your goals.

I have my Roth in one of the Janus mid cap funds. I don’t remember the criteria I used to pick the particular fund, but I know that longevity and track record were a part if it. I chose mid cap because I was lacking in that area overall. I also have a traditional IRA that has a mix of stocks and large and small cap funds. I’ll be converting that to a Roth next year, most likely. And you’re right, opening a Roth is easy.

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Gerty

10 years ago

Thanks for the great info JD!

I have a Vanguard target-date fund through work and will be using most of our tax refund to open an IRA for my partner. When it’s time to sit down and seriously get ready to open the IRA, these resources will be great to go back through.

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Donna

10 years ago

Thanks for this post. I plan to start (finally!) retirement planning in February, and this post is very helpful. Bookmarked for future use!

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Mightyjo

10 years ago

I have my Roth IRA at Ing ShareBuilder. They’re a fee-free custodian and discount broker. I use their Automatic Investment Plan service to sock away a chunk of every paycheck into a no-fee large cap index fund and occasionally buy some shares in a small cap index fund, too. Automatic trades cost $4 each, or less if you buy a monthly package for investing in more than one fund/stock.

I like it. I moved to ShareBuilder from my bank’s brokerage where I was paying out all my earnings in custodial fees. Live and learn.

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Little House

10 years ago

thanks for the info on these three companies. I like the sound of the T. Rowe Price one, low minimum to get started and a waived minimum for only $50 per month deposits. I think I’ll start this soon!

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Elizabeth

10 years ago

Thanks a bunch! I was just thinking about how I’d rather get my money into a Roth than the TSA I have at work (I REALLY don’t trust AIG!).

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Kevin M

10 years ago

@JD – please pass this along to Lynn. You can have her email me if she has a question.

Depending on her actual Adjusted Gross Income, she might be eligible for the retirement savers’ credit.

$41,000 is right near the top of the 10% credit bracket for the head of household status (which I assume she is with 2 kids and single). She might be better off doing a regular IRA and deducting it, thus lowering her AGI to qualify for the credit.

For example, if she qualifies and puts $5,000 in the IRA, she would get a federal tax credit of $500.

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JBLenoir

10 years ago

Quick question –

Combined, my wife and I are not too far off from the $160k mark allowed to contribute to a Roth IRA.

Assuming (hopefully) that our income continues to increase over the next few years, we should surpass the limit.

What would happen to our Roth IRA in that case? I’m assuming I just wouldn’t be able to contribute to it anymore?

Thanks!

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Eric

10 years ago

It IS easy to open a Roth IRA and start saving!! I opened mine with T.Rowe Price back in January of ’08. I enrolled in Automatic Asset Builder so as to avoid having to pay the $1000 minimum to open. I’ve since bumped up that monthly contribution to $150. Easy as pie! Deducts right from my checking account automatically, no need to do anything on my part from month to month except to be sure to include the $150 in my monthly budget. Since I have at least 30 years until retirement, I picked a highly ranked (by Consumer Reports)… Read more »

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Seamus

10 years ago

Another point to note is that, at least with T Rowe Price, they charge the $10/year fee per mutual fund you are invested in until the balance is 5K. If considering TRP you might want to choose a target date until you have enough to branch out fee free. If you are starting with a $50 initial investment and a lower per month investment, it would take awhile and great deal of fees before multiple funds reach the fee free balance minimum.

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KEN

10 years ago

I have a Roth IRA. It is a good investment vehicle. While the down market hit it hard, I’m leaving it alone because I’m investing long term.

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Parker

10 years ago

I am 19 and want to start saving. I currently do not have a job. Are there any options available to me?

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Garrett

10 years ago

This makes sense. What I don’t understand is what the difference is between my 401(k) and an IRA. I know the 401(k) involves my employer and an IRA is something I do on my own. Can I max them both out? Should I ignore this if my employer matches a large % of my 401(k) contribution? Is IRA better if you expect to move jobs in the next year or two? These are the kinds of questions that keep me from opening one.

Thanks, Garrett

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CamKC

10 years ago

For some light relief, check out this billionaire laughing at people who pay into a retirement fund, and see him explain why its a crazy way to be anything other than poor in retirement. His chuckling is most infectious – you’ll be laughing too, when he’s finished the explanation. Laughter starts around 6 and a half minutes in, and breaks out repeatedly throughout. Interesting angle on how ordinary folk get repeatedly screwed despite their best, most earnest efforts to “do the right thing and save”, while the rich know that “ain’t the way to go”. Definitely worth a few moments… Read more »

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Kristin @ klingtocash

10 years ago

Excellent post. Very well explained.

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Tyler Karaszewski

10 years ago

What is the advantage of a Roth IRA over just opening an account with an investment firm?

It doesn’t have the tax-defferment that my 401k does. It has really arbitrary seeming limits on it. What is the benefit here over just buying these sorts of investments through my schwab account, where I don’t need to worry about income levels or annual maximums?

Strangely, the article didn’t cover this at all — why are these better than any other option?

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Rebecca

10 years ago

My first two IRAs were stupid mistakes, but remarkably easy to set up. I opened my first one at (the former) WaMu: it was a mutual fund filled with bank stocks. I knew nothing except that it was April 14 and I was “supposed to” invest. My second one was with Scottrade: not bad, but I never knew which stocks to buy, so the funds just sat in a money market account. Now, I have a Vanguard Target account – easy, no thinking, no stressing, automatic investing, low fees. I still need to get my act together and close/transfer my… Read more »

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JerryB

10 years ago

Tyler (#16), your standard brokerage account is taxed on dividends and if you sell any of the investments to rebalance. The Roth IRA isn’t, it grows tax free and when you retire the monies can be withdrawn tax free. You can also balance your account options within the Roth IRA without paying taxes on what you sell, provided the net profit stays in the Roth IRA. My RothIRA is with Vanguard. I’m currently in the S&P 500 Index and will quite possibly be adding one of their international funds in 2010. All my bonds are held in my 401k (Fidelity)… Read more »

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Mike Piper

10 years ago

Tyler,

J.D. states, “earnings from a Roth IRA can be withdrawn tax-free at retirement.” That pretty much sums it up.

Granted, that’s not the case in every single situation. (Here’s a flowchart explaining how to know whether withdrawals will be tax-free.)

For anyone curious: My own retirement accounts are all invested via Vanguard index funds or ETFs.

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Rosa

10 years ago

@Tyler – the benefit is the tax benefit when you take the money out. Personally, given the size of our federal debt, I assume taxes will be higher when I’m older. You might not think so, and that will change how much benefit you think the Roth will have for you. I <3 Vanguard, my Roth is there and it’s all low-cost index fund. One reason to be cautious with your retirement account & use a separate brokerage account for riskier stuff is that when you’re still working, if you take stock losses you want to have them offset non-tax-advantaged… Read more »

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Jacque

10 years ago

@CamCK #14

Wow. Sounds like a bunch of BS from a guy making his millions conning people in to buying his books. From the few minutes I watched of the video, I’d never take anything someone quoted from Rich Dad, Poor Dad without a GIANT grain of salt.

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Craig

10 years ago

The Roth IRA really has helped me out with my retirement savings. I was so confused and still don’t know anything about specific accounts and what not, but a lifecycle fund has really helped me get started and now I feel more secure.

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E

10 years ago

I just started a Roth this year, with a T. Rowe Price target date fund, contributing $100/mo. It was important to me to start a Roth somewhere, somehow, and T. Rowe Price had several advantages: user friendly website, low fees, and low required monthly contribution. I have a conventional IRA and a 401k; I started the Roth to provide a little bit of tax balance. I was considering converting my conventional IRA but I’m already going to pay so much in taxes this year – the marriage penalty is going to hit us hard – that I don’t want to… Read more »

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Kevin M

10 years ago

@JBLenoir – Yes, if you are earning more than the Roth contribution limits, you just can’t contribute new funds those years. Your can still keep your Roth open with the funds contributed in earlier years.

@Parker – you have to have “earned income” to qualify to contribute to any IRA. This includes things like wages, commissions, self-employment income, etc. It doesn’t include things like investment income, pension, social security, etc.

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Saundra

10 years ago

I am really enjoying reading the GRS posts and the comments and I think it is important to note that each one of us must take the time to learn about the investment options prior to choosing to invest. JD is right that the “vehicle” (Roth, Traditional, Taxable) and the “allocation” (which stocks/funds you invest in) are two different issues). The important thing to remember about financial planning is that there is no “best answer” for everyone. Deciding to open a Roth or a Traditional IRA should take into account your tax planning as well as your retirement needs. Do… Read more »

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Nicole

10 years ago

When I was just out of college and had no idea what I was doing, I simply went to my local bank and asked them about Roth IRAs. They were perfectly happy to sit down with me and explain things slowly and in detail and started one for me with a short-term CD (they also explained CDs and money market accounts to me). Since an IRA is, as JD explained, just a bucket to hold an investment, once I became a little more savvy, I was able to cash out the matured CD and move the IRA over to E-trade… Read more »

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J.D.

10 years ago

I want to re-iterate that I’ve tried to keep this particular post to just the very basics. There are a lot of ifs with saving and investing, a lot of special cases. If you want more detail, feel free to leave a comment, or to look at the other info I linked to, or to contact a financial pro. But these are the basics.

@CamKC (#14) Robert Kiyosaki is not a reliable source for retirement information. Entrepreneurship? Sure. But not retirement saving.

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Nicole

10 years ago

@JBLenoir: You get to keep the Roth IRA you opened this year. It continues to accrue tax free. If your income exceeds 160K (or whatever the limit is) next year, you have to open up a new regular IRA for the new money from next year (or at least some of the new money). We both have Roth and Traditional IRAs based on our income in different years. If we make under 160K, like this year, we fund our Roth IRAs. If we make over the limit (this happened once), we fund our traditional IRA. I *think* in 2010 there’s… Read more »

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Miss Moneypenny

10 years ago

I opened up my first Roth IRA with USAA when I was 20 and I’m not even sure what mutual funds I picked. I only funded once with 250 before I got scared. Now I use a Sharebuilder IRA to invest.

Starting in 2010, there won’t be an income limit for converting traditional IRAs to Roth IRAs, so even if you open up a traditional IRA this year b/c you make over the income limit, you could convert it into a Roth IRA next year.

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CamKC

10 years ago

@Jacque and @JD – Yes I take your points. I liked the video because it was so “left field” compared to the usual, and often most warranted, serious worries about the fine and complex details of retirement planning. He put it all in a totally different context – forcing some of us to take a “bigger view” of the whole landscape – and it made me laugh that we take all this so seriously, when in fact the whole game we’re earnestly trying so hard to play fairly, may be fundamentally flawed in its design and conception. But I take… Read more »

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Ever

10 years ago

I am a 28 year old who makes about $50,000 a year. I put away 5% into my 401k and get a 5% company match. I also get an additional 4% put into a pension plan. I have a small Roth IRA, but I stopped contributing to it because I have about $7,000 in credit card debt. I am paying it off as I can. Should I continue contributing to my Roth IRA while I pay off my debt? I have savings tied up in the stock market, and do not want to take those funds out because I’d be… Read more »

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Rick Francis

10 years ago

@Donna Why wait- until feb? Even if you don’t have extra income you can start the process now and be ready then! Lynn, I feel the confusion and understand that all of the information is overwhelming! You don’t want to act and make a horrible mistake. However, waiting is a big mistake, here is why: http://ponderingmoney.com/2009/11/04/funding-retirment-is-painfulunless-you-start-early/ Why not break the complexity down into simple enough steps so that you can take some action today? Find provider — as JD said you don’t need to find the absolute best provider- you can always change your mind later and transfer to another… Read more »

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chacha1

10 years ago

Tying up savings in the stock market is exactly what you DON’T want to do, unless those “savings” are in a tax-advantaged account: either a 401k or traditional IRA in which the money went in pre-tax (this reduced your taxable income, so you will pay taxes on the withdrawals after eligibility); or a Roth IRA, in which the money went in after tax (you will pay no taxes on the withdrawals); or a Health Savings Account, which can be either pre-tax or after-tax. Playing the market without taking into account capital gains taxes is dangerous for almost everybody. Keeping your… Read more »

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Caroline

10 years ago

For “set it and forget it” IRA ease, I like the Target Retirement Fund options at Vanguard. You choose your estimated year of retirement, and it automatically changes your balance of stocks and bonds to follow your changing risk tolerance. Target Retirement Funds seem to be index funds, which I got into after reading a book called “Naked Economics” that made a really convincing argument that over the long term, you won’t do better than the market as a whole. Since retirement investment is by definition long-term, I figured index funds were a good choice. It also keeps me from… Read more »

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Suzanne

10 years ago

@ Jacque 21:

LOL, I couldn’t agree more. Rich Dad Poor Dad’s Philosophy of Life: If you buy it, the income will follow. Just spend tons of money, and then you won’t have any choice but to increase your income! Not everyone on earth is an entrepreneur and/or real estate mogul at heart.

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Suzanne

10 years ago

Also, I read that Target Date Funds have a lot of fees in them. I have all of my retirement savings in ETFs with very low fees. I have appropriate percentages in an S&P ETF (80% of my funds) and the rest in a treasury-bond ETF (20% of my funds).

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Ever

10 years ago

#33, Thank you for the advice. I am very nervous to sell my current investments right now. Many of them are up over 100% in just a few short months, and my brother who is an investor has told me they will probably go up another 100% in a year or two. (I’m talking about stocks like BAC, C, and other financials.) I bought at almost the bottom of the market. Also, I like to think of this as my “emergency savings” account. I have more than 1 year worth of savings in there. I am just so concerned with… Read more »

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Mike D

10 years ago

Does anyone have an opinion on Trade King? 4.95 trades and no fees supposedly.

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brooklyn money

10 years ago

Nearly everyone is not able to qualify for a Roth due to the income restrictions. Many people in my area (NY/NJ/CT)are disqualified because of our “high” salaries. Not so high when everything costs 2x as much here as the rest of the country. And yes, I would move if I could. I’m thinking about doing the conversion next year but don’t really feel like paying income tax on $20,000, even if I can spread it out over 2 years.

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Adam

10 years ago

@Ever #33 – If you think they’re going to go up, sell now, wait 30 days and buy again in your Roth IRA. If you think you’re worried about capital gains now, you’ll be even more worried about them if your stock DOES double in 2 years. Why not put it in a Roth, then get your gains tax free? That said, I will agree with the sentiment that you should consider paying off your debt before investing, especially in a taxable account. If it were me, I’d sell 20k in stock, pay off the debt (7k), save 3k for… Read more »

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Stephanie

10 years ago

1. Opening a Roth IRA is *very* easy. 2. In order to contribute to a Roth IRA you must have *earned* income in the fiscal year. Investment income? Doesn’t count. Money you had in savings and want to add to your Roth IRA so that you don’t fall as far behind in retirement savings just because you are unemployed? Not happening. Retroactively removing a contribution is no fun. In my case it was slightly easier because I had no earnings and I removed it before the tax year in which I contributed it ended so it was easier to deal… Read more »

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Mike Piper

10 years ago

@Mike D. I really like TradeKing–I recommend them on my blog quite frequently.

Customer service is great. Interface is easy to use. Trades are cheap. (I’m a miserly old man when it comes to investing. Low-cost ETFs and index funds for me!)

And they allow for (free) automatic reinvestment of dividends–which is important to me when dealing with ETFs in an IRA.

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Ever

10 years ago

@ Adam #40

That is a very good idea Adam. I hadn’t even considered that as an option. I can just set aside extra money to pay the capitals gains tax.

@ Mike D – I use TradeKing. After setting up the accounts and transferring the money in I found out that ETFs are considered Mutual Funds and so the trades are $15.95 each! They have a great selection, but be careful. I think it’s fine for individual stocks, but if you’re looking at murual funds or ETFs, see if another brokerage is cheaper.

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Mike Piper

10 years ago

Suzanne: I suspect you accidentally mixed up the ticker symbol–putting in the index fund version of a fund rather than the ETF version of it (VTSMX rather than VTI for instance). ETF trades at TradeKing are only $4.95. I make a couple every month.

I set up a Roth last year with T. Rowe Price. I already had a 401(k) with them. The setup process was simple and only took 10-15 minutes to do.

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Leah

10 years ago

I finally opened a Roth IRA this summer (due in large part to this blog!). I’d been meaning to for ages. I opened mine at schwab.com because of the low minimums and also because I wanted to use their checking account. I’ve got my money invested in a few index funds, which is really easy to do with them. It’s fun to watch it grow, and I’m looking forward to adding more when I get a job again.

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Rick Francis

10 years ago

@Ever If your CC interest rate is high enough it will make sense to stop contributing to pay off the debt. As long as you put the payments you would have made on the credit card into retirement contributions. It may even make sense to forgo your 401K Match!!

-Rick Francis

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Hi! I’m J.D. Roth. I'm here to help you master your money — and your life.

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General Disclaimer: Get Rich Slowly is an independent website managed by J.D. Roth, who is not a trained financial expert. His knowledge comes from the school of hard knocks. He does his best to provide accurate, useful info, but makes no guarantee that all readers will achieve the same level of success. If you have questions, consult a trained professional.

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